DP8983 | Managing Currency Pegs

Publication Date

21/05/2012

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Abstract

The combination of a fixed exchange rate and downward nominal wage rigidity creates a real rigidity. In turn, this real rigidity makes the economy prone to involuntary unemployment during external crises. This paper presents a graphical analysis of alternative policy strategies aimed at mitigating this source of inefficiency. First- and second-best monetary and fiscal solutions are analyzed. Second-best solutions are prudential, whereas first-best solutions are not.